“I do believe that crypto is digitising gold in many ways” — Larry Fink, CEO of BlackRock.
The arrival of the first Spot Bitcoin ETF is one of the most anticipated events in the crypto space. It is seen as a milestone where a brand new class of investors will be exposed to Bitcoin with a clear regulatory landscape, better liquidity, and greater convenience. Undoubtedly, this event could have a significant impact on price.
To estimate the effect of a Bitcoin ETF approval, we will first compare it with the arrival of the first Gold ETF in 2003. Then, we will estimate the potential inflows that a Spot ETF could generate to form an opinion on the potential price impact that it could have on Bitcoin.
The Bitcoin ETF: A “Deja Vu” Feeling
“ETFs were a game-changer for gold because they brought new investors and new demand into a market with relatively fixed supply. Sound familiar?” – Matt Hougan, CIO of Bitwise.
In the 1990’s, owning physical gold carried a poor reputation among investors. It had a history of being subject to government confiscation sales tax and was often a prohibited investment for fund managers.
During this era, investors seeking exposure to the gold price often opted for shares in gold mining companies rather than acquiring physical gold, much like how investors bought stocks in Coinbase or Microstrategy during the last crypto bull market.
However, things changed at the onset of the 21st century. In March 2003, the first Gold ETF: GBS, was launched on the Australian Stock Exchange. A year later, the US followed. The idea behind those ETFs was simple: issue nominal value shares backed by physical gold. This is the same model currently behind Bitcoin’s Spot ETF.
As those ETFs gained popularity, they ignited a substantial demand for physical gold.
In the first year of inception, around 400 tons of gold were bought by the ETF Providers. Four years later, the cumulative gold demand from these providers had surged to around 1600 tons (Please refer to the chart from the World Gold Council).
Drawing a parallel with Bitcoin
Gold, in contrast to Bitcoin, serves many other purposes beyond merely being a “store of value”. It is used in jewellery, technology, or industrial production. Based on our estimates, only 25% of the total gold supply is allocated for investment purposes (taking the average distribution of gold by sector from 2016-2023, figure 2).
To draw a comparison with Bitcoin, we can apply this 25% to the total supply of gold in 2004, which stood at around 140,000 tons and suggest that the “investment supply” of gold was about 35,000 tons in 2004. In our analysis, we will assume that this supply is a proxy for Bitcoin’s total supply 21,000,000.
Therefore, if the ETF providers demanded 400 tons of gold in the first year, this constituted approximately 1.15% of the “investment gold” supply. Four years later, the demand climbed to 1600 tons, accounting for roughly 4.5% of the gold investment supply.
Estimating the amount of Bitcoin demanded
The Spot Bitcoin ETF is quite similar to the rise of Gold ETFs back in 2003, and if we suppose that Bitcoin’s adoption path parallels that of gold, we can infer that ETF providers will demand 1.15% of Bitcoin’s supply during the first year. This represents around 250,000 Bitcoins that would need to be bought by the different ETF providers to back their product.
For context, there are currently roughly 1,800,000 Bitcoins held on spot exchanges. Hence, if Bitcoin’s journey aligns with that of gold, approximately 15% of all Bitcoin held on exchanges would need to be acquired with fresh USD. This could cause a significant market shift.
Exploring Things from a Different Angle
So far, we’ve used the trajectory of the first Gold ETF to gauge the potential influence of the ETF on Bitcoin’s supply dynamics. Now, we will shift gears and adopt a different perspective by evaluating the potential impact of the ETF approval on Bitcoin’s price.
Why Institutional Portfolio Will Care?
The first step in this approach is to understand why Bitcoin is becoming increasingly appealing to traditional financial institutions. To do that, we will look at a study by Bitwise that evaluates the impact of incorporating Bitcoin into a traditional 60/40 portfolio.
First, the chart from Bitwise (figure 4) clearly illustrates that a bitcoin allocation would have resulted in a significant improvement in the portfolio performance. For instance, a 2.5% allocation would have increased the cumulative return by 101%.
Further, it is important to emphasise that these results were achieved without affecting the portfolio maximum drawdown (24,24% compared to 22.67% without Bitcoin) or its volatility (10.88% against 10.59% without Bitcoin).
Hence, Bitcoin presents a fantastic opportunity for institutions to diversify and outperform their peers with a relatively small allocation needed.
Traditional institutions are beginning to recognise the absolute advantage of incorporating Bitcoin into their portfolios. This may trigger a race among institutions to be the first to adopt Bitcoin once the ETF receives approval and generates a lot of inflow as the ETF becomes a reality.
Forecasting Potential ETF Inflows
Here are the TradFi institutions that showed an interest in Bitcoin:
Collectively, this represents a staggering $ 40,000 billion in Asset Under Management (AUM) that understands the merit of allocating money into Bitcoin to increase the robustness and diversification of their portfolios.
Building on the previous scenario of a 2.5% bitcoin allocation target in the first year post-approval, we can envision three different scenarios depending on the rate at which these different asset managers embrace this shift in portfolio dynamics:
Based on this, we project a base case with an initial inflow of $100 billion into a Bitcoin ETF in the first year following the launch.
Evaluation of the Price Impact on Bitcoin
While this new inflow of money will most certainly have a significant impact on price, it is important to realise that there is no exact and definitive method for accurately estimating the actual impact that it may have on price.
Here, we will draw our own estimation by comparing it with the launch of the first gold ETF.
We can see that this launch coincides with the beginning of a 10-year bull market on gold, where it rose by more than 350%. In the first year of inception of the US ETF, from Nov 2004 to Nov 2005, Gold Price rose by 20% with a yearly inflow of $USD 15 billion in the different ETFs.
While various factors influenced the price of gold at the time and could be responsible for the price increase, the emergence of ETFs undeniably played a significant role in this trend.
But, let’s be conservative in our analysis and assume that ceteris paribus, only 25% of that price movement was due to the inflow from the ETF, with the rest being attributable to other factors such as:
- Negative real interest in 2004
- War in Iraq (that started in 2003) caused fear of inflation at the time
- China opening its market for precious metals for the first time
This suggests that a $15 billion inflow from the ETF moved gold by 5% back in 2004.
Considering the total above-ground gold supply and the prevailing market price of gold during that year, the estimated market cap of Gold was roughly $ 1,300 billion. This figure is approximately double the current market cap of Bitcoin. Therefore, if Bitcoin behaves similarly to gold in 2004, an influx of $ 7.5 billion could potentially result in a 5% price increase.
However, it is important to note that Bitcoin has demonstrated significantly greater price sensitivity than gold in numerous instances. One approach to quantify this relative sensitivity is to examine their respective annualised volatility.
In 2004, gold exhibited an annualised volatility of 16%, while Bitcoin’s volatility during the last bull market was approximately 81%. Based on this, we can infer that Bitcoin was roughly 5 times more price-sensitive than gold in 2004.
In this context, a $ 7.5 billion inflow would drive bitcoin up by 25%.
Following this line of thought, we can derive the potential price impact of the ETF inflow in year:
We estimate the base case scenario in Year 1 to be a 330% increase in Bitcoin price, while our more optimistic scenario aligns more with a 500% price increase.
The consensus among different experts is quite broad. Some, like Cathie Woods, argued that Bitcoin could see a 15x increase, while reports from other entities like Galaxy are more conservative, estimating a +74% increase. Therefore, our analysis stands within the middle range of the expert consensus.
Final Remarks
The above analysis has examined the impact of the ETF approval on the price of Bitcoin by estimating the potential dollar inflows and deriving the resultant price effect.
While our analysis suggests a scenario in which Bitcoin could appreciate by more than 330% in the first year following the Bitcoin ETF approval, it is important to note that this is only an estimate. Determining the actual impact is hard, if not impossible, due to the multitude of variables that could influence the outcome. Further estimating the price impact of a particular inflow is also exceedingly challenging, and only time will reveal the true price effect of the ETF.
To sum up, the ETF approval is poised to have a substantial positive impact on Bitcoin by bringing it further into the attention of the mainstream and onboarding a brand new class of investors. That is why we’re very bullish about the impact of Bitcoin ETF on the crypto market.
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